I work for a LO manager. I have a little less than five years in the industry although have prior work experience. We do fundamental work and average a two year holding period. I see opportunities to generate relative outperformance in many places. I do not think it is easy but would think it is possible for the collective intellectual capabilities of previously successful hedge fund managers.
So I am really curious as to why these funds are failing sort of en masse (Eton Park, Perry Capital, Brevan Howard, etc.)? I recognize that some of these funds are macro-oriented but I feel like even the equity-focused long-short players have struggled as well.
I have a couple of hypotheses. These are based on trying to identify something that has changed over the last say five years or so.
For macro funds maybe QE everywhere has distorted historical relationships. Government intervention is notoriously unpredictable, especially for the libertarian hedge fund crowd that may be less amenable to "non-rational" thinking.
But more focused on long-short/stock-picking funds, what has changed?
Another possibility is the rise of high speed trading. It seems to me that a good number of hedge funds historically have been founded by "traders" (as opposed to say an equity research guy). A trader generates alpha by having short-term information advantages. I suspect that the ability to exploit these short-term advantages has been eroded by high speed trading. For a generic example, "word" comes to connected hedge funds that numbers are too low for a given company. They begin to initiate a position but algorithms pick up on the trade and increase the cost. There may be other variations of this theme.
I acknowledge headwinds from the publicity associated with the fee structure and/or historical claims of consistent quarterly outperformance. The former has no effect on performance. The latter does but funds have always pitched this.
For those of you in the industry, what has changed?
Or maybe I am mistaken that the long-short fund industry is struggling?
Very very few hedge funds actually have a process/ infrastructure in place that's more than "we have a smart CIO and smart analysts are cheap." If the CIO is unlucky or dumb (and they tend to get dumber/ lazier as time goes on) then its all over. The real question is why so many mediocre big funds remain open
This is tough b/c its constantly evolving and a lot of it is organizational structure type stuff.
Basics/ before: Repeatable investment process not dependent on the CIO bing brilliant at decision making, personnel processes to continually recruit and retain best talent. None of these things are/were really about capital
Now (increasingly): Heavy technology and research/ data investments. Heavy compliance investments. A lot of things that require upfront capital investment.
Some of the firms with the technology, research, etc are actually kind of terrible on the people front (think multi-managers) but it doesn't matter b/c smart ppl are a plentiful and cheap and you can churn them through the system
What's amazing/ annoying is how many funds have neither of these things, but once had a really smart CIO put up huge numbers and ride that reputation forever despite no longer being any good
HF's make the bucks by bringing money in, not beating the market. Although it's common for someone to think they are failing because they are down %age wise, its important to note that hedge funds, among other funds, have bad years.
"For example, a hedge fund managing $1 billion charges a fee of 2% of those assets per year plus 20% of trading profits.
Let's assume the fund breaks even — no profits. That's still $20 million in fees. When a hedge fund controls $20 billion, the income is $400 million."
This is the structure of fee's. Now assume the fund continues to perform like shit, then, guess what? People are going to pull their money.
With this in consideration, hedge funds don't necessarily have to promise anything. They perform well collect the fee's and then their children have a decent 20 million sitting in their trust funds. This can bring about a sense of complacency. "We do it big for 5 years, everyone eats, we collect more assets, then we can relax." Unfortunately, there is no relaxing in the market, but they know exactly what they are doing
People like Ackman will continue to perform well because they are all about making a name for themselves, and once they have made it, they need to ensure that it stays polished.
Whats the solution? Lower fee's and operate on a profit performance basis. This will ensure that grifters are put to rest, and hedge funds wont just milk people for fees.
A few reasons:
-Fees have generally been too high in the past.
-Hedge funds are designed to provide uncorrelated returns, not beat indexes. Its not surprising that they are not beating indexes (especially after fees) when they were never designed to do so.
-Due to downward pressures and unwarranted pressure to beat indexes, a lot of funds are more or less closet indexing, so they underperform indexes (after fees) while being more or less correlated.
-A lot of funds rely on a one particular persons prior record to raise money with no promise of actually recreating those results or proving it was anything other than luck.
-We have been in an almost decade long bull market. Active management underperforms in bull markets and overperforms in bear markets - in general.
-Picking individual stocks is very, very hard to do consistently over the long term. Even if you can, most of the time it is just survivorship bias / extended period of extreme luck.
-Investors in hedge funds do not understand investment processes or how to track returns, so they pull $$ at the first sign of things going south.
-People like Buffet are popularizing the notion that hedge fund managers are taking exorbitant fees while not providing much in the way of alpha.
-People in general, are starting to hate hedge funds even more than in the past for whatever reason (Bernie Sanders? Idk)